Interest-Free Loan from a Foreign Parent Company – Accounting Treatment

When a company receives interest-free loans or loans with an interest rate below market terms from its foreign parent company, the proper accounting measurement of such liabilities is of particular importance. Under IFRS for SMEs, an entity may apply Sections 11 and 12 or opt for the guidance set out in IAS 39; however, regardless of the chosen accounting policy, certain principles remain mandatory.

At initial recognition, a financial liability is generally measured at the transaction price, except in cases where the arrangement represents a financing transaction, meaning that payment is deferred beyond normal commercial terms or the loan is granted without interest or at a below-market interest rate. In such situations, the liability cannot be recognized at its nominal amount but must be discounted, i.e., measured at the present value of future cash flows using a market interest rate for a similar financial instrument. While discounting is often not required in practice for short-term loans, it becomes mandatory for long-term loans prior to the preparation of financial statements.

Where the IAS 39 approach is applied, financial liabilities are initially recognized at fair value, including transaction costs (except for liabilities measured at fair value through profit or loss), and are subsequently measured at amortized cost using the effective interest rate method. This method ensures that the effect of discounting is recognized over time, gradually aligning the carrying amount of the liability with its nominal value.

It is particularly important to emphasize that the difference between the nominal amount of the loan and its discounted value is not recognized as income but is recorded directly in equity. This prevents artificial inflation of profit resulting from favorable financing terms provided by a related party.
Additionally, if the loan is denominated in a foreign currency, the liability must be adjusted using the official exchange rate, and any resulting foreign exchange differences are recognized in accordance with applicable accounting standards.